Registered Reps
FINRA Announces Escalation of High-Risk Broker Program edit
Thursday, November 28, 2013 12:28

Tags: compliance | FINRA

Facing government pressure to crack down on the industry's most problematic registered representatives, FINRA announced a program in February 2013 to focus on what it deems "high-risk brokers."  Now FINRA is expanding the program.

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As a result of this initiative, FINRA has conducted expedited investigations of 42 advisors, and barred 16 individuals, according to a letter recently published by FINRA's CEO, Richard Ketchum.
Mr. Ketchum's letter indicated that FINRA will be expanding the high-risk broker enforcement program in 2014, including the creation of a dedicated team to investigate misconduct.
Ketchum did not describe the exact methods that FINRA's Office of Fraud Detection and Market Intelligence uses in order to identify advisors engaging in suspicious conduct. However, in addition to the high-risk broker enforcement program, FINRA utilizes a computerized risk-analysis "broker migration model" to track representatives who previously worked at FINRA Member Firms that have been expelled, as well as a separate "problem broker model" tool that scrutiinzes representatives who have had multiple customer complaints or other serious problems disclosed on their CRD records. 
Overall, FINRA barred 1,342 registered representatives from the industry from January 2011 through September 2013.

Board of Governors Authorizes FINRA To File Recruitment Compensation Proposal With SEC edit
Thursday, October 10, 2013 09:50

Tags: breakaway brokers | compensation | FINRA | registered reps

The Financial Industry Regulatory Authority (FINRA) today announced that its Board of Governors approved a proposal requiring brokers to disclose recruitment compensation paid to them as an incentive to move to a new firm. The proposal needs to be submitted to the Securities and Exchange Commission (SEC) for review and approval. If approved, brokers would need to disclose their recruitment compensation to any customers that choose to follow them to their new firm for a full year.

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The proposal contains two components, according to a FINRA press release: a disclosure obligation and reporting to FINRA. The disclosure requirement would apply to recruitment compensation – including signing bonuses, up-front or back-end bonuses, loans, accelerated payouts, and transition assistance – of $100,000 or more, and to future payments (trade-based or asset-based) contingent on performance criteria. Firms would be required to disclose to their customers the compensation paid to the transferring representative in ranges. The first range would be $100,000 to $500,000; the next would be $500,000 to $1 million; followed by increasingly larger bands.




Are Brokers Fiduciaries, Even Though They Accept Commissions? Yes, Says Financial Advice Ethics Expert Ron Rhoades edit
Wednesday, May 22, 2013 15:41

Tags: compensation | Dodd-Frank | fiduciaries | fiduciary standard

A lot of fee-only advisors think that advisors who accept commission compensation cannot be fiduciaries. That’s not necessarily true. Legal experts say the Securities Exchange Act of 1934 imposes a fiduciary obligation on brokers accepting commissions similar to the fiduciary standard under the Investment Advisers Act of 1940, and financial advice ethics experts Ron Rhoades published a pamphlet earlier this week saying that brokers are required to act as fiduciaries under state common law. Yet the issue continues to be highly contentious and has been the main sticking point separating Financial Planning Coalition and groups representing fee-only advisors from groups like Financial Services Institute, representing registered reps.

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With financial regulators and Congress wrestling with how to implement the Dodd-Frank Act, figuring out who should regulate RIAs, and being urged to consider creation of a single fiduciary standard that would apply to all financial advisors—fee-only and commission, I emailed Rhoades several questions about the obligation of commission-compensated brokers to act as fiduciaries. Below are Rhoades’ answers to my questions about how brokers can accept commissions and still be a fiduciary.  
Please elaborate on the issue of advisors accepting commissions and still owing a fiduciary responsibility to clients.
If commissions are agreed-to in advance with the client, are reasonable in amount for the services and advice provided, and no additional compensation to the broker results from the sale of the product (such as other forms of revenue-sharing arrangements), then the commission fee structure is essentially the same as paying an agreed-upon fixed fee for the advice to be provided, given the amount to be invested. However, difficulties exist with commissions, in several respects:
First, is the amount of the compensation reasonable? If all you are doing is recommending an asset allocation to the client, and picking mutual funds, and if you charge 4% of $1,000,000 invested across multiple fund complexes, these acts might very well result in unreasonable compensation for the services provided. In each case, expert testimony is required to examine the services provided, and to determine whether the fee is “reasonable” under the fiduciary standard for the advice which is provided. There are many, many different circumstances in which brokers are currently operating on a commission basis, where the compensation might be viewed by an expert as unreasonable.
Second, have you as a fiduciary limited yourself too much, in terms of the products being able to be accessed? Dodd-Frank permits a broker, if the fiduciary standard is applied, to have a limited range of product offerings. Even then, the SEC may place limits on this practice.
Third, have you avoided all differential compensation? As stated above, differential or variable compensation is difficult to defend under the “best interests” fiduciary standard, and likely prohibited under ERISA’s tougher “sole interests” fiduciary standard.
You say, "Commission‐based compensation is not, in and by itself, contrary to fiduciary principles, provided the commissions do not vary with the advice being given and provided that the compensation received by the advisor is reasonable for the services provided." What do you mean about commissions varying with the advice being given?
Technically, the “best interests” fiduciary standard of conduct does not prohibit commission-based compensation, nor does it prohibit additional compensation being paid to the fiduciary from a third party. In theory, there is nothing different from a flat fee being charged for one-time investment advice, versus a commission; the only difference is how the fee is computed (not necessarily the amount), and who pays it (either way, it results in a payment from the client, whether direct or indirect).
The problem arises when the amount of compensation varies depending upon the advice which is given. For example, if one product pays a fiduciary 6%, plus 0.25% trailing fee indefinitely, while another product pays a fiduciary only 4% with no trailing fee, then the fiduciary has a financial incentive to recommend the higher-cost product. In this respect, the fiduciary bears the burden of demonstrating, in a court of law (or arbitration), that the client is not harmed by paying a higher fee. Since substantial economic evidence demonstrates that higher-fee products possess, on average, lower returns, it becomes very problematic for the fiduciary to try to justify his or her actions.
Given the higher attention being paid by litigation attorneys to fiduciaries who recommend (or, in the case of plan sponsors, approve the selection of) higher-fee-and-cost products, it is only a matter of time before some client of a fiduciary would challenge the fiduciary in an arbitration or legal proceeding. In my mind, the better way is to avoid the conflict altogether. Specify and agree with the client on the amount of compensation to be paid, in advance of any recommendation being undertaken. Then adhere to that amount of compensation.
Of course, the business practices of Wall Street will be forced to change, under a levelized compensation approach. Gone will be the insidious practices of payment for shelf space (a type of “pay-to-play” arrangement), soft dollar compensation, and other compensation structures which result in the fiduciary (individual or firm) receiving greater total compensation as a result of recommending X product, instead of Y product.
Even fee-only advisors possess conflicts, however, which may cause differential compensation. The classic examples involve whether to purchase a fixed immediate annuity, or to pay off a mortgage or other debt. In both instances, a fee-only advisor whose fees are based upon the amount of investment assets managed would possess a conflict of interest. In these instances, fiduciary advisors must be very careful to justify the advice that they provide. There may be solid reasons to not purchase an immediate annuity for a client who is retired (there are many factors at play). There may be good reasons to not pay down a mortgage (due to deductibility of interest, possible low interest rate being paid relative to returns obtained in the capital markets, etc.). This is a case where the conflict of interest is unavoidable, and must be properly managed. Fee-only advisors are to be applauded for avoiding commission-based compensation, and other third-party payments, which can result in conflicts of interest. Yet, fee-only advisors may, in some instances, still possess a conflict of interest, which must in such instance be properly managed.
If an advisor can accept commissions and still be a fiduciary under ERISA, can a broker be a fiduciary on nonqualified assets?
Yes, and the broker is probably already a fiduciary. Most brokers, I would observe, are already fiduciaries under state common law.
And are you saying that the broker is a fiduciary under the ‘34 Act?
Not under the ’34 Act. But, rather, fiduciary status arises under state common law. Here’s the key. A person registered under the ’40 Act, and operating as an investment adviser, is automatically a fiduciary. At the time the 1940 Investment Advisers Act was adopted, everyone thought it imposed fiduciary duties. (The U.S. Supreme Court only confirmed that fact, in its seminal 1963 Capital Gains decision.)
A person registered under the ’34 Act may be, and often is, still a fiduciary. It was commonly known (and stated by NASD, now known as FINRA, and by the SEC, in the early 1940’s) that brokers were fiduciaries when they provided personalized investment advice—i.e., when they formed a relationship of trust and confidence with the client. Fiduciary status results not from the application of the ’40 Act (which relates only to whether registration is required), but due to the application of state common law.
The ’34 Act, unlike ERISA, does not preempt the application of state common law, as to the application of the fiduciary standard of conduct. Many, many brokers (and even some insurance agents) are found to be fiduciaries, applying state common law. In fact, the #1 complaint in arbitration proceedings against brokers in the past five years has been for “breach of fiduciary duty.”
When the ’40 Act was enacted, nowhere in the ’40 Act did it state that brokers were not fiduciaries. Indeed, it was commonly known at the time that brokers were fiduciaries when providing personalized investment advice—i.e., when in a relationship of trust and confidence with the client. And simply by the use of a title such as “financial consultant,” or a designation such as “financial planner,” the broker has taken the necessary step to invite the client into, and accept, a relationship of trust and confidence. Every instance is still a facts-and-circumstances analysis, yet most brokers – who pride themselves in knowing their clients, meeting with them regularly, etc. – have likely formed the relationship of trust and confidence which results in fiduciary status being imposed, as to those clients.
Can a broker get paid different commissions depending on the class of shares of a mutual fund and still be a fiduciary?  
Technically, yes under state common law and under the Advisers Act, but not under ERISA (unless the DOL grants exemptive relief in this area). Differential compensation under ERISA would violate its strict “sole interests” fiduciary standard and ERISA’s prohibited transaction rules.
For example, in the retirement space arena a mutual fund may have share classes which vary from R-1 to R-6. R-1 may have a 1.00% 12b-1 fee (which is passed on to the brokerage firm in a revenue-sharing arrangement), while class R-6 might have a 0.05% annual 12b-1 fee. Other classes would have fees in between. This permits the fiduciary advisor to negotiate, in advance with the client, what the fees to be received will be. (Even then, I think 12b-1 fees are fraught with problems, including anti-competitiveness.)
If the agent is being paid a straight commission, then the commission should be negotiated in advance between the fiduciary and the client. Any product which fits within that commission level can then be considered by the fiduciary. (A disclosure must be made that other products will not be considered by the fiduciary, and the ramification of that limitation should likewise be explained to the client). If, however, no agreement is made in advance with the client as to the maximum amount of commission to be charged, then the selection of a fund with a higher commission becomes problematic, for the reasons noted above.

If a Customer Arbitration Goes Badly, Advisors and Firms Must Work Together to Salvage the Situation edit
Thursday, April 25, 2013 09:21

In FINRA arbitrations brought by disgruntled customers, Claimants routinely sue both the rep and the firm.  If the arbitration Panel issues a severe Award against you that makes no sense, your only recourse may be to bring a civil lawsuit demanding the Award be vacated pursuant to the Federal Arbitration Act.  The question arises however: what happens if you want to sue to vacate, but your firm just wants to pay up and move on--can you move forward alone?


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Recently, a Federal Court in Michigan issued a decision that bears directly on this issue.  In Intervest International Equities Corporation v. Aberlich, (12-CV-13750, E.D. Mich.) Defendant Aberlich was an investor who obtained a large damage Award against several parties in an underlying FINRA arbitration.  After the decision was issued, Intervest filed a civil lawsuit to have the decision vacated.  Aberlich sought to have Intervest's case thrown out, arguing that because not all of the Respondents in the underlying FINRA case had joined the lawsuit, the judge did not have the authority to take up Intervest's action to have the Award thrown out.  


The judge agreed with Aberlich, finding that it was essential that all the same parties to the FINRA case also be parties to the lawsuit challenging the Award, and that the court could not provide complete relief without all the same parties being in the new case.  The court reasoned that, because Claimants and all the Respondents agreed to be bound by the Award by virtue of their Arbitration Agreement, it could not consider whether the Award should be vacated or confirmed without all the Respondents from the arbitration participating in the challenge, and that to rule otherwise would be prejudicial to both the Claimants and the non-participating Respondent.


This decision has important implications for your professional reputation in the event you are sued in a FINRA customer arbitration.  In the event the Award does not go your way, and you want to file a lawsuit to get the decision overturned, your firm will have to agree to participate in the separate lawsuit.  Absent that participation, you may be stuck without a remedy, much like Intervest was in this case.  Having a frank discussion early on with your firm's legal department about its willingness to challenge a negative Award in the event the arbitration goes badly will help inform your litigation strategy, and whether you have a need to retain separate counsel to represent your interests.

FINRA Considers Proposal Mandating Greater Consumer Access To BrokerCheck Through Web Links edit
Monday, September 24, 2012 06:43

Tags: broker-dealers | FINRA | registered reps | regulation

FINRA has drafted a proposal mandating that broker-dealer websites contain a link to its BrokerCheck system. The proposed amendment would also cover any website maintained by or on behalf of anyone associated with of member firms.

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The move makes it clear that FINRA wants consumers to have greater awareness of and access to BrokerCheck. FINRA is also weighing what additional information should be included on the public database.
There was considerable pushback in February of 2012 on an effort to include broker test scores. So much so that FINRA chief Richard Ketchum declared in May that FINRA had no interest in collecting such data.
But investment-related civil actions brought by a state or foreign regulatory body against those associated with a suit that has been dismissed because a settlement agreement was reached may become permanent information on BrokerCheck records.
Currently, many of the 4379 FINRA licensees provide no links to BrokerCheck, nor do broker profiles listed by firms.
BrokerCheck shows work profiles and regulatory histories of both current and former registered reps and broker-dealers.
FINRA has been searching for ways to better inform investors about broker and firm regulatory histories to equip investors with improved due diligence capability.


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